Thursday, July 3, 2008

“When it comes to measuring or sensing stock market volatility, I do not follow the VIX.”

Now I may have invented that silly tagline, “Your one stop VIX-centric view of the universe,” but I am the first to argue that a defaultist mind set is the wrong way to approach the investment landscape. If you follow the same indicators with the same default settings as everyone else, you are setting yourself up not just to follow the crowd, but to be a half step behind it. In order beat the crowd, what is needed is a variant perception.

Back to HEDGEfolios for a moment:

“The key element of volatility using traditional methods like the VIX rests on the reversal at extremes in a contrarian indication such as buying when the VIX exceeds 30. This is a very dangerous concept and I do not advocate for its use… I never liked that approach so I do my own thing and look at each stock, the turnover in each and how the composite of all signal changes indicates the market volatility.”

Volatility is a wide-ranging concept. It can be defined, measured and applied to over 10,000 stocks and ETFs in many different ways. To think that best way to harness information about volatility is to buy when the VIX hits X is ludicrous.

Consider that the concept of volatility can be applied not just to price, but to volume, options prices, market breadth data, etc. Volatility is a characteristic of every slice of the almost infinite flow of data that is associated with the markets.

It’s not just what you measure, it’s how you measure it. Volatility can look forward when it is in the form of a forecast or a derivation, such as implied volatility. When volatility looks backward, the opportunities to get creative are even richer. There is historical volatility, average true range, Bollinger bands, Chaikin volatility, relative volatility, and a variety of ways in which to index volatility.

Go ahead and watch the VIX, but don’t think for a moment that you are going to have an advantage over the thousands of other people who are watching the same indicator. Sure, you might come up with the next great VIX permutation, but you are far more likely to get a leg up on the competition by revisiting some basic questions:

Is volatility worth following?

How can more knowledge about volatility make me a better investor?

Which aspects of volatility should I pay attention to?

How should I measure that type of volatility?

How do I interpret those measurements for maximum ROI?

One of my favorite measures of volatility is the number of buy and sell signals my various systems generate each evening. It’s simple, but effective. And I can be sure that nobody is not going to show up on CNBC tomorrow touting the same approach.

Purpose of this Blog

The intent of this blog is to educate, inform and entertain readers, while also serving as an archived learning laboratory of sorts as I try to sharpen my thinking in areas such as volatility, market sentiment, and technical analysis. I also enjoy charging off on tangents and hope that readers may find some illumination or at least amusement in these forays.

Reviews of VIX and More

About Me

Chief Investment Officer at Luby Asset Management LLC in Tiburon, California. Previously worked as a full-time trader/investor and also a business strategy consultant. Education includes a BA from Stanford and an MBA from Carnegie Mellon.
Useless trivia: I once broke the world pogo stick jumping record without knowing it.